Warnings from otherwise soft-spoken analysts that the ballooning U.S. federal debt will inevitably lead to a fiscal crisis have become commonplace. Consider, for example, Mitch Daniels, the White House Budget Director in the Bush II administration, who recently wrote: “With debts already about to surpass the nation’s entire GDP…only a dwindling number of denialists doubt that a cataclysmic reckoning…lies ahead.”

Not so fast. While the debt will surely exact a cost on future generations, these costs manifest gradually and will likely not be of crisis proportions over any reasonable planning horizon. That’s not to say a fiscal crisis isn’t possible. We think it is. But any such crisis would likely follow from political missteps rather than as a direct consequence of the debt accumulation. Unfortunately, such political missteps seem more likely today than in recent decades.

Plainly, there is considerable uncertainty about the repercussions from federal debt rising to levels far exceeding historical precedents – and in any case, relying on historical relationships may understate the risks of a crisis. Yet our analysis suggests that (a) so long as the U.S. maintains its strong financial and legal institutions, along with a fiscal trajectory that isn’t vastly worse than the one currently projected, and (b) policymakers remain committed to making timely payments on interest and redemption, the chance of an economic meltdown stemming from debt over the next few decades appears low.

So, What's at Stake?

This projection follows from persistent “primary deficits” (deficits excluding interest payments) averaging roughly 2.2 percent of GDP over the next 30 years. Those deficits reflect rising spending alongside relatively flat revenues. Spending on the biggest ticket items, Social Security and major health programs, is largely driven by a combination of population aging and stubbornly rising health care costs.

How do deficits exact a cost on the lives of people in the future? We will try to explain briefly and with only modest pain.

Deficits are costly to future generations to the extent that they reduce national saving or – another way of saying the same thing – to the extent that the spending and revenue policies that create those deficits increase consumption. A reduction in national saving tends to reduce private investment, as the government and business compete for the same pot of dollars. Now, the effect of a reduction in national saving on private investment can be offset in part by an influx of foreign capital. But that still means giving up claims on future U.S. output to those foreigners With or without the foreign capital, the bottom line is clear: reduced national saving stemming from rising deficits means that future generations of Americans will have less income than they otherwise would.

How large are these effects? Notable, but not huge. According to the CBO, if the debt to-GDP ratio were to remain at its current level, income per capita in 2054 would be 52 percent higher in real terms than it is today. In contrast, with debt rising from 98 percent of GDP in 2024 to 166 percent of GDP by 2054, the income growth figure is knocked down to 46 percent. A real difference, but arguably not a game changer.

To be sure, over the very long run, the negative effects of debt rising faster than output would eventually cut deeply into prosperity. But under a wide range of fiscal policies, that day is well beyond a reasonable planning horizon.

The Future Will No Doubt Differ from CBO Projections 

CBO’s forecast is, of course, subject to great uncertainty, and the effects of rising debt on future living standards could be substantially larger than projected. The big wild cards are the pace of economic growth and the cost of federal borrowing. If growth is slower than expected or interest rates higher, the debt trajectory would likely be more worrisome. Remember, too, that CBO’s budget projection may be too optimistic because it assumes no new legislation. For example, the CBO baseline assumes that none of the expiring provisions of the Tax Cuts and Jobs Act – the tax cut enacted in 2017 – will be extended. Yet that extension (and new tax cuts) is a high priority for the political party now controlling both Congress and the White House. By the same token, the baseline assumes that “discretionary” appropriations  – funding for programs allocated through the appropriations process – will be allowed to fall as a share of GDP over the next decade.

Modeling more realistic legislative outcomes would worsen the fiscal outlook substantially. CBO has examined an alternative scenario under which both tax revenues and discretionary spending are a constant share of GDP equal to their historical average. These assumptions have a marked impact on the level of debt: instead of reaching 152 percent of GDP in 2049, it reaches 244 percent in that year. Nonetheless, despite this massive rise in debt, CBO estimates that per capita income in 2049 would be only 5 percent lower than in CBO’s baseline  – still leaving future generations better off than current ones because there would still be sustained economic growth over the quarter-century.

What's Required to Stabilize the Debt?

As discussed above, debt represents an intergenerational transfer: higher consumption today leaves less to consume in the future. That transfer can be arrested by stabilizing the debt as a share of GDP.

Using CBO’s projections, we calculate that, if the debt rose as projected under current law to 166 percent of GDP by 2054 and then actions were taken to stabilize the debt-to-GDP ratio, taxes would have to increase or spending would have to be cut by 3 percent of GDP. If half were done on the tax side and half on the spending side, taxes would end up as 20.3 percent of GDP and spending would be 25.8 percent, compared to 17.5 percent and 23.1 percent, respectively, in 2024. While this represents a 16 percent increase in taxes compared to 2024, it would still leave overall tax revenues as a share of GDP well below the current OECD average. Indeed, even if all of the adjustment were done on the revenue side and no action was taken until 2054, the resulting tax burden as a share of GDP would still be lower than the current OECD average.

How much smaller would the adjustment be if we did it now rather than wait? Acting now to stabilize the debt instead of kicking the can until 2054 would lower the magnitude of the adjustments needed from 3.0 percent of GDP to 2.1 percent. That is, waiting 30 years before taking action to stabilize the debt increases the required adjustment in taxes and/or spending by roughly 1 percent of GDP

Two conclusions follow. First, waiting to stabilize the debt increases the required adjustment, but not by a crushing amount. Second, while the required adjustments to fiscal policy to stabilize the debt would be sizable (either now or, more so, later), tax burdens would still remain moderate by international comparisons. As we discuss below, the constraints and risks are more political than economic.

What Could Cause a Fiscal Crisis?

To know what could cause a fiscal crisis, first we have to define it. A fiscal crisis is a large, persistent downturn in demand for Treasury securities relative to supply that triggers a sharp and sustained jump in interest rates. That large increase in rates would most likely be accompanied by a dramatic fall in both the exchange value of the dollar and the prices of U.S. stocks. Given the critical importance of Treasuries in global financial markets, the crisis would probably lead to a financial crisis, meaning widespread bank losses and a collapse in access to credit.

A global recession would likely follow. The global financial system relies heavily on Treasuries for collateral in loan transactions such as repurchase agreements (aka repos). Thus a sudden loss of confidence would impair liquidity, potentially leading to bank failures. Interest rates on consumer and business debt tied to Treasury yields – such as mortgages and small business loans – would soar, lowering asset values and leading to defaults

Global equity markets would experience a sharp downturn, while sovereign wealth funds and foreign central banks holding Treasuries could face solvency concerns. Consider, too, that the resolution of the fiscal crisis might require a sudden turn to fiscal austerity, with sharp increases in taxes and cuts in government spending that in themselves could induce a recession in the United States, adding to financial market stress.

Here, we examine four scenarios that might lead to a crisis.

Scenario One: A Sudden Change in the Demand for Treasuries

One common concern is that investors in U.S. Treasuries might abruptly decide to dump their holdings, which could lead to a flood of debt hitting the market. A similar glut could happen on the supply side if the U.S. Treasury needed to borrow significantly more than expected in a short period of time. While such developments would put upward pressure on interest rates, further effects could arise from ensuing market panic.

The U.S. experience with quantitative tightening – planned and orderly sales of Treasuries by the Federal Reserve  – is instructive. When the Fed reduces its portfolio of Treasuries, it has to offer terms to induce others to buy them. Federal Reserve economists estimate that $2.5 trillion in quantitative tightening (about 9 percent of all Treasuries, which amounts to 2.5 times China’s total holdings) could raise interest rates by about half a percentage point. This relatively modest impact suggests that a large-scale sell-off by investors wouldn’t roil the markets as much as feared.

That said, the Fed’s quantitative-tightening programs sell Treasuries in a slow, planned manner, while an investor sell-off or a similarly sized unexpected increase in supply of Treasuries on the market would be more abrupt and could lead to panic. In that case, the Fed would most likely take actions to smooth any increase in interest rates owing to persistent changes in supply and demand, as it did during the March 2020 panic selling at the start of the pandemic.

The Fed’s ability to calm investors amid market disruptions would, however, be more challenging if the Fed’s credibility were simultaneously in question. The Fed would need to make sure market participants did not interpret its intervention (which would likely include temporary purchases of Treasuries) as an abdication of its mandate to maintain low and stable inflation. The Fed would have to reassure investors that if a reduction in demand for Treasuries relative to supply raised the neutral rate of interest, the Fed would adjust its policy accordingly once markets were stabilized. Such reassurance would be exceedingly difficult if the Fed’s credibility was already in question.

Note, too (in light of recent events), that serious challenges to Fed independence or reinterpretations of the Fed’s mandate could undermine investors’ faith that the agency would respond effectively to crises – and thus exacerbate the threats of a sudden change in demand for Treasuries. While the Fed certainly has the will and the means to intervene today, it is possible that changes such as greater limits on its ability to purchase Treasuries, or more political pressure on the Fed, or changes among the Federal Open Market Committee participants – could make it less able or willing to do so.

Scenario Two: Threats of Default From Political Brinkmanship

Over the past several years, the U.S. has had some near misses with respect to policymakers allowing the debt limit to bind and thus potentially restrict payments by the Treasury, only acting within days to clear the way for additional borrowing to finance spending obligations. This flirtation with delayed payments has led credit rating agencies to downgrade the U.S. debt, but, at least to date, doesn’t appear to have had any enduring effects on Treasury borrowing costs.

What would happen if Congress didn’t act in time? Much would depend on how long the impasse lasted, whether the Treasury prioritized interest payments over other forms of spending, and how investors interpreted the episode in terms of the likelihood of similar episodes in the future. The behavior of the Fed is also key. As discussed above, the Fed could take action to calm Treasury markets should panic arise in an event like a failure to raise the debt ceiling. In 2011, for example, monetary policymakers discussed purchasing defaulted Treasury securities and treating them as having the same value as non-defaulted securities in order to preserve market liquidity. This option, though considered “loathsome” by some monetary policymakers because of the optics of having the Fed seem to circumvent Congress, was generally accepted as a necessary action in extreme circumstances to prevent panic.

If investors decided that a protracted default brought on by the failure to raise the debt ceiling had a real chance of occurring without congressional intervention, Treasury rates could rise sharply. Note, moreover, that policymakers could credibly threaten to default on the debt in other ways besides allowing the debt ceiling to bind. For example, in 2020, Senator Lindsey Graham supported cancelation of the U.S. debt held by China. Other types of default have also been in the news – for example, the so-called Mar-a-Lago Accord based on current Council of Economic Advisers chair Stephen Miran’s proposal to charge foreign holders of short-term Treasuries a “user fee” on interest payments.

If worries of a default triggered a persistent sell-off, the spike in rates could be large enough to create a financial crisis. But rather than resulting from debt mismanagement, this crisis would be the result of political missteps that could occur whether the debt was 50 percent of GDP or 250 percent.

Scenario Three: The Temptation of Higher Inflation

Some argue that the Fed will be pressured to allow more inflation so as to lower the real value of the debt (and the real cost of repaying it), sometimes referred to as “fiscal dominance.” But this doesn’t seem to be a significant cause for worry because even runaway inflation would have limited impact on our fiscal obligations and would be hugely unpopular. In any event, it couldn’t happen without a radical change in the Fed’s central charge to control inflation.

Backing up for a moment: why does inflation have such limited ability to lower the debt burden? Two reasons. Most importantly, because the main fiscal challenge we face is continuing imbalances between revenues and non-interest spending  – not interest on the current stock of debt. Second, a rise in inflation only lowers the real interest rate (interest rates less inflation) on existing securities. Interest rates on new securities  – including those issued when the debt is rolled over (refinanced)  – rise one-for-one (or more) with inflation, offsetting any benefit.

Given that the average maturity of the U.S. debt is short, inflation has limited ability to lower the debt burden. For example, even if inflation were higher by 10 percentage points in every year over the next 30 years, the debt-to-GDP ratio would still rise significantly under current law: from 98 percent in 2024 to 134 percent in 2054. That’s instead of 98 percent to 166 percent of GDP if inflation remained close to the Fed’s current target.

Because most of the debt expires and must be rolled over within just a few years, one might argue that a persistent increase in inflation is not necessary. Perhaps the Fed could engineer a short period with very high inflation – say 30 percent – and then return to target. That strikes us as fanciful. The Fed’s current tools aren’t sufficiently powerful to raise the price level by that much. Witness the many years in the 2010s in which inflation remained below target in spite of the Fed’s efforts to get inflation to stay at 2 percent. Furthermore, any move to temporarily boost inflation would undoubtedly destroy Fed credibility and lead investors to believe that such a move would reoccur, raising inflation expectations and interest rates on new Treasury securities.

Scenario Four: Strategic Default in the Face of a Worsening Fiscal Outlook

Under any realistic fiscal outlook, strategic default – the intentional default on U.S. debt – is exceedingly unlikely within any reasonable planning horizon because the benefits would be so much smaller than the costs. To start, the benefits of walking away from financial obligations would be quite small because the U.S. would immediately surrender its ability to borrow cheaply in capital markets and would thus need to immediately balance the federal budget.

For example, if the U.S. defaulted in 2054, the federal government would need to equalize spending and revenue – which would require increasing taxes by 12 percent or cutting spending by 10 percent. By contrast, forgoing default and instead stabilizing the debt-to GDP ratio in 2054 would require only incrementally larger adjustments of 16 percent higher taxes or 14 percent lower spending.

The costs of default would far outweigh those modest fiscal benefits. First, because about 70 percent of the debt is held by Americans, most of the savings from foregone interest payments would be at the expense of U.S. households. Second, a default would almost certainly trigger a severe global financial crisis, inflicting significant economic damage on U.S. households through loss of jobs and savings. Third, the federal government would lose the ability to run deficits during economic downturns or to respond effectively to crises such as pandemics or wars.

But what if, within a reasonable planning horizon, the debt appears on track to become so large that we couldn’t repay it without enormous harm to the economy? In that case, might strategic default – and loss of access to credit markets for at least some period – be a better option?

If lenders to the federal government saw this as a possibility, interest rates would soar, which would only serve to increase the probability of default.

One possible scenario over the next several decades is that Congress enacts legislation that balloons the debt– say, by eliminating taxes on corporate profits and Social Security benefits, or by enactment of Medicare for All, or by provision of a hefty Universal Basic Income. Investors might conclude that Congress had abandoned all fiscal discipline and thus might also raise their projections for future deficits, increasing the probability of eventual strategic default either directly through nonpayment or through hyperinflation.

Whether such a scenario led to a protracted financial crisis would depend on whether policymakers changed course in response to investors’ concerns. An episode in the UK is instructive  – and perhaps reassuring. In September 2022, then-Prime Minister Liz Truss introduced a mini-budget that included significant unfunded tax cuts, startling financial markets and leading to a sharp increase in borrowing rates. The Bank of England immediately stepped in to calm markets, the prime minister quickly reversed her proposals and interest rates on government bonds retreated.

If circumstances were similar in the U.S., it is worth considering the potential role of the Fed. The Federal Reserve’s role as lender of last resort can help restore confidence in Treasuries in the case of a run – when most sellers are offloading Treasuries primarily out of fear that others will do the same. If some investors begin to worry about the trajectory of fiscal policy and interest rates start to spike, the Fed could likely stabilize Treasury markets temporarily by buying bonds. By doing so, it would provide fiscal policymakers with a critical window to reassure markets that bond default is not on the table – perhaps by taking meaningful steps to address the nation’s long-term fiscal challenges, as was the case in the UK during the Truss episode.

What if something like this happened in the U.S., but policymakers didn’t change course? If investors came to believe that the U.S. was never going to address its long-term fiscal challenges and that strategic default on the debt was really a serious possibility, the result could well be cataclysmic. The federal government could lose access to capital markets, making it unable to roll over its debt. And the Fed’s ability to intervene effectively would likely be severely constrained. As a part of the federal government, the Fed would struggle to maintain credibility if investors believed there was a high probability of default.

As explained by Olivier Blanchard, the former chief economist of the IMF, central banks should work to fully mitigate market panic when it is “for no good reason,” but should only work to “limit contagion and induced financial crises” if markets move abruptly for more fundamental reasons. Ultimately, the nation must address its fiscal challenges by either raising taxes or cutting spending.

A perceived unwillingness to contemplate these steps would likely lead to a fiscal crisis, even with a Fed willing to act as a lender of last resort. But, as we noted above, because the costs of allowing such an event to unfold would be so disruptive for the global economy, it is far more likely that policymakers would act preemptively to restore fiscal discipline and avoid financial collapse.

Focus on the Biggest Reasons for Concern

The ongoing accumulation of debt relative to GDP coupled with persistent projections of more to come has made fiscal indiscipline an ongoing issue in policy debates. Yet, despite decades of worry over the risks of mounting debt, analysts often fail to define what they are worried about with any specificity. The ongoing accumulation of debt will almost surely erode future prosperity. This gradual effect occurs as government deficits lower national saving, which in turn is likely to reduce private investment, shrink the size of the capital stock, boost foreign ownership of U.S. capital and raise interest rates, all reducing living standards down the road. A very different concern – the one this essay examines – is that rising debt will somehow lead to a crisis in Treasury markets, which will spill over into the broader financial sector with the potential to upend the U.S. and global economy.

We acknowledge that debt growth at a rate far exceeding historical precedents and its consequences are terra incognita. But there is reason to believe that, so long as the U.S. maintains strong legal and financial institutions and a fiscal trajectory that isn’t vastly worse than the one currently projected, the chance of a fiscal crisis from debt accumulation over the next few decades is very low. The catch, of course, is that in the current environment, those conditions cannot be taken for granted.